Educational tax credit eligibility

We previously established a Section 529 College Savings Plan for our daughter, who just started college this year.

We previously established a Section 529 College Savings Plan for our daughter, who just started college this year. Part of her first year’s tuition is being paid from the Section 529 Plan distribution. Can we claim an educational tax credit for the additional costs that we pay for her education?

As long as your daughter is claimed as a dependent on your return and the payout from the 529 Plan isn’t used for the same expenses for which you are claiming the credit, you are eligible to claim the educational tax credit on your return. However, eligibility for the full tax credit is restricted to married doctors whose adjusted gross income does not exceed $90,000. Five percent of the credit is lost for each $1,000 of adjusted gross income above $90,000.

Alternatively, if your daughter provides over half of her support from her own earnings or amounts spent from gifts, custodial account funds, her own savings, or from distributions from a family limited partnership or family limited-liability company account, she may be able to claim the tax credit on her return. In that event, the family would still be entitled to the benefits of the tax credit, notwithstanding the fact that your income is too high to claim the credit on your return.

I have made some substantial profits in two rental real estate properties and would like to cash them out. This would involve substantial federal and state income taxes on the gain. Accordingly, I would like to defer all taxes using a tax-free exchange. Unfortunately, the prospective seller for the new property does not want to take these two properties in exchange for the new one and insists on me paying cash. How can I handle this to avoid taxes?

Using a delayed tax-free exchange, you should be able to accomplish your objective. First, locate buyers for your current properties. These contracts for sale can then be assigned to a “qualified intermediary,” who receives the cash at closing and places it into an escrow account. You then have 45 days from the date of the sale to identify the new property you wish to purchase, and 180 days from the original sale date to actually close on the new property. Note that this time period may be shortened to the extent that you file your tax return prior to the expiration of the 180-day period.

Once you select a new property to purchase, the qualified intermediary will provide the cash from the escrow account at closing. Since the money does not pass through your hands, you are not treated as having received it, and thus no gain is taxed. Please note that upon the sale of the property received, the taxes on the original gain must be paid, unless you enter into a new tax-free exchange or the property is sold following your date of death.

My parents wanted to help our children out with college educational expenses. Accordingly, they placed $55,000 into a Section 529 College Savings Plan for each of our three sons several years ago. It is my understanding that the entire amount is exempted from gift tax since it is treated as being made over a five-year time period. Does this mean that our sons cannot use any of the money for college purposes until five years have expired?

No. Regardless of when the money is actually spent for tuition, the annual gift tax exclusion will apply to one-fifth of the $55,000 gifted for each of the following five years.

I am concerned about possible malpractice claims. I have heard that all amounts held in retirement accounts are protected from the claims of creditors. Is this true?

Retirement plans that qualify for favorable tax benefits under the Employee Retirement Income Security Act of 1974 (ERISA) are protected from the claims of creditors. Such qualified plans include 401(k) profit-sharing plans, defined benefit pension plans, money-purchased pension plans, and regular profit-sharing plans.

You should know that courts have held that SEP-IRAs and SIMPLE-IRAs are not ERISA-qualified plans and therefore do not receive the same asset protection from the claims of creditors. As a general rule, the protection of these and other types of IRA accounts would be determined under state law, which has jurisdiction over these plans. In some states, these assets are protected from creditor’s claims, while in others they are not.

Accordingly, if one of your primary aims is to protect your assets from the claims of creditors, you are best served using an ERISA-qualified plan.

John K. McGill is a tax attorney, CPA, and MBA, and is the editor of The McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($209 a year) and consulting information are available from John K. McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217. Call (704) 424-9780, or visit the Web site at www.bmhgroup.com.

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